The Smart Money: Progressive versus regressive taxation

This chart demonstrates how progressive taxation works. Everyone pays a base level of taxation, but those who earn more pay a bit more as income increases. (Courtesy Pearson)

by Gina Hamilton

Well, it's that time again, when people utter a heartfelt oath as they sign a check to U.S. Treasury, Internal Revenue Service, and bemoan what they are paying in income taxes.

Everyone has a favorite boogeyman, and for some, it's what the government is spending on the military and the NSA. For others, it's what the government is spending on the school lunch program. And just an aside -- the school lunch program costs next to nearly nothing compared to military and homeland security expenditures. But we'll look at what you're getting for your tax dollar next week.

That Congress has the power to tax -- Article I, Section 8, also known as the "tax and spend" clause -- is not in dispute. The Constitution says that they can tax to pay debts, for common defense, and the general welfare, as long as the taxation is done "uniformly" throughout the United States.

The power to tax for the general welfare was interpreted narrowly according to the ennumerated powers -- such as establishing post offices and the like -- until 1936, when the Supreme Court ruled in United States v. Butler that "[T]he [General Welfare] clause confers a power separate and distinct from those later enumerated, is not restricted in meaning by the grant of them, and Congress consequently has a substantive power to tax and to appropriate, limited only by the requirement that it shall be exercised to provide for the general welfare of the United States..."

Since then, things have expanded a bit, one might say.

But how Congress chooses to tax is up to them. Congress might have decided to go with a consumption tax of some sort, like a value added tax or a national sales tax. It might have chosen to tax property ownership. It might have chosen to increase tariffs and other trade-based taxes.

Instead, it chose to tax income, for one of the most singular and democratic reasons in American history. They taxed income because everyone, not just wealthy property owners, would be taxed, and because the tax structure could be worked so that those who earned more paid a larger percentage than those who earned less.

What a concept.

The income tax was begun initially to pay for war debts. Fifty years after the end of the Civil War, the US still owed money to cover the costs of repairing the greatest conflagration in American history. The sixteenth amendment was enacted to pay for some of those debts. World War I and the Depression and World War II meant the 16th was never rescinded. After WWII, the Cold War used up all the oxygen in the room, along with the Marshall Plan, veterans' programs, the space race, the national highway system, and indeed, ultimately, by the sixties, education and welfare programs for other people. Soon, the U.S. was monitoring what was going into food and drugs, and taking baby steps to protect the environment. Banking regulations began during the Depression and continued until they were rescinded or changed in the late 1990s.

The highest marginal tax rate immediately after World War II was 94 percent; that is, if you were superwealthy, you paid the same percentage that the peasants paid for the first $20 thousand, then a bit more for the next $50 thousand, then a bit more for the next $100 thousand, and so on until your final tax rate -- for the highest part of your income -- was 94 percent.

Rich people were still very rich, but the nation gradually worked its way out of debt, and together with a strong unionized workforce, a thriving manufacturing economy, and a living wage for everyone else, the postwar period until the Reagan years were known as golden economic times for the U.S., despite high debt and a lot of spending. They were good times for everyone. While recessions continued to hit, they were short in duration, and when they ended, the economy more than bounced back.

If the U.S. had chosen instead a VAT tax or some other consumption tax, and did not exempt food, clothing, shelter, transportation, health care, and other basic necessities of life, those at the bottom of the economic ladder would have paid a larger percentage of their income in tax than those at the top, even though they could least afford to do so.

Why? Because for the poor, nearly every dime that flows into their hands flows right back out to pay for necessities. Someone earning $20,000 per year may pay $2,000 for health care, another $3,000 for food and clothing, $5,000 to maintain a car and buy gas and insurance, and virtually the rest on shelter, heat, and utilities. If the federal government had imposed a 10 percent consumption tax, the poor person would have to pay $2,000 in tax on everything he spent, which is 10 percent of his income.

A wealthier person, earning $100,000 per year, may also spend $20,000 on necessities and maybe even an additional $10,000 on other things -- a vacation, a new sailboat, a new set of skis and so on. The rest is saved or invested. His total taxation would be $3,000 for the year, or 3 percent of his income. While the wealthier person pays slightly more in actual numbers, the "flat" nature of a sales tax means that as a percentage of income, the poor are harder hit than everyone else.

Also regressive are property taxes, and they are difficult to get to conform to the "uniformity" clause. A city dweller in a condo may have a "property" that is valued the same as a Maine farm encompassing 200 acres. The farm can be used to produce income, whereas the condo cannot. If the farmer cannot pay property taxes, he can sell part of the land; the condo owner has no such recourse.

Of course, there are local property taxes, and they make it possible to see how a large property tax would affect those who are on fixed incomes or have low incomes. Many seniors have been forced to sell their homes as property tax on their homes rose and their income did not. State sales tax is often exempted for food and medicine, as it is in Maine, and in some places it is exempted for clothing, heating fuel, and other necessities. This makes it somewhat more progressive.

But two people buying a necessary vehicle to get to work will pay the same in sales tax, whether one earns $100,000 or $20,000. The way this balances out is through the income tax, so that the poorer person can pay less in payroll tax than the richer one.